The Google Fund for the French Press

 

At the last minute, ending three months of  tense negotiations, Google and the French Press hammered a deal. More than yet another form of subsidy, this could mark the beginning of a genuine cooperation.

Thursday night, at 11:00pm Paris time, Marc Schwartz, the mediator appointed by the French government got a call from the Elysée Palace: Google’s chairman Eric Schmidt was en route to meet President François Hollande the next day in Paris. They both intended to sign the agreement between Google and the French press the Friday at 6:15pm. Schwartz, along with Nathalie Collin, the chief representative for the French Press, were just out of a series of conference calls between Paris and Mountain view: Eric Schmidt and Google’s CEO Larry Page had green-lighted the deal. At 3 am on Friday, the final draft of the memorandum was sent to Mountain View. But at 11:00am everything had to be redone: Google had made unacceptable changes, causing Schwartz and Collin to  consider calling off the signing ceremony at the Elysée. Another set of conference calls ensued. The final-final draft, unanimously approved by the members of the IPG association (General and Political Information), was printed at 5:30pm, just in time for the gathering at the Elysée half an hour later.

The French President François Hollande was in a hurry, too: That very evening, he was bound to fly to Mali where the French troops are waging as small but uncertain war to contain Al-Qaeda’s expansion in Africa. Never shy of political calculations, François Hollande seized the occasion to be seen as the one who forced Google to back down. As for Google’s chairman, co-signing the agreement along with the French President was great PR. As a result, negotiators from the Press were kept in the dark until Eric Schmidt’s plane landed in Paris Friday afternoon and before heading to the Elysée. Both men underlined what  they called “a world premiere”, a “historical deal”…

This agreement ends — temporarily — three months of difficult negotiations. Now comes the hard part.

According to Google’s Eric Schmidt, the deal is built on two stages:

“First, Google has agreed to create a €60 million Digital Publishing Innovation Fund to help support transformative digital publishing initiatives for French readers. Second, Google will deepen our partnership with French publishers to help increase their online revenues using our advertising technology.”

As always, the devil lurks in the details, most of which will have to be ironed over the next two months.

The €60m ($82m) fund will be provided by Google over a three-year period; it will be dedicated to new-media projects. About 150 websites members of the IPG association will be eligible for submission. The fund will be managed by a board of directors that will include representatives from the Press, from Google as well as independent experts. Specific rules are designed to prevent conflicts of interest. The fund will most likely be chaired by the Marc Schwartz, the mediator, also partner at the global audit firm Mazars (all parties praised him for his mediation and wish him to take the job).

Turning to the commercial part of the pact, it is less publicized but at least as equally important as the fund itself. In a nutshell, using a wide array of tools ranging from advertising platforms to content distribution systems, Google wants to increase its business with the Press in France and elsewhere in Europe. Until now, publishers have been reluctant to use such tools because they don’t want to increase their reliance on a company they see as cold-blooded and ruthless.

Moving forward, the biggest challenge will be overcoming an extraordinarily high level distrust on both sides. Google views the Press (especially the French one) as only too eager to “milk” it, and unwilling to genuinely cooperate in order to build and share value from the internet. The engineering-dominated, data-driven culture of the search engine is light-years away from the convoluted “political” approach of legacy media that don’t understand or look down on the peculiar culture of tech companies.

Dealing with Google requires a mastery of two critical elements: technology (with the associated economics), and the legal aspect. Contractually speaking, it means transparency and enforceability. Let me explain.

Google is a black box. For good and bad reasons, it fiercely protects the algorithms that are key to squeezing money from the internet, sometimes one cent at a time — literally. If Google consents to a cut of, say, advertising revenue derived from a set of contents, the partner can’t really ascertain whether the cut truly reflects the underlying value of the asset jointly created – or not. Understandably, it bothers most of Google’s business partners: they are simply asked to be happy with the monthly payment they get from Google, no questions asked. Specialized lawyers I spoke with told me there are ways to prevent such opacity. While it’s futile to hope Google will lift the veil on its algorithms, inserting an audit clause in every contract can be effective; in practical terms, it means an independent auditor can be appointed to verify specific financial records pertaining to a business deal.

Another key element: From a European perspective, a contract with Google is virtually impossible to enforce. The main reason: Google won’t give up on the Governing Law of a contract that is to be “Litigated exclusively in the Federal or States Courts of Santa Clara County, California”. In other words: Forget about suing Google if things go sour. Your expensive law firm based in Paris, Madrid, or Milan will try to find a correspondent in Silicon Valley, only to be confronted with polite rebuttals: For years now, Google has been parceling out multiples pieces of litigation among local law firms simply to make them unable to litigate against it. Your brave European lawyer will end up finding someone that will ask several hundreds thousands dollars only to prepare but not litigate the case. The only way to prevent this is to put an arbitration clause in every contract. Instead of going before a court of law, the parties agrees to mediate the matter through a private tribunal. Attorneys say it offers multiples advantages: It’s faster, much cheaper, the terms of the settlement are confidential, and it carries the same enforceability as a Court order.

Google (and all the internet giants for that matter) usually refuses an arbitration clause as well as the audit provision mentioned earlier. Which brings us to a critical element: In order to develop commercial relations with the Press, Google will have to find ways to accept collective bargaining instead of segmenting negotiations one company at a time. Ideally, the next round of discussions should come up with a general framework for all commercial dealings. That would be key to restoring some trust between the parties. For Google, it means giving up some amount of tactical as well as strategic advantage… that is part of its long-term vision. As stated by Eric Schmidt in its upcoming book “The New Digital Age” (the Wall Street Journal had access to the galleys) :

“[Tech companies] will also have to hire more lawyers. Litigation will always outpace genuine legal reform, as any of the technology giants fighting perpetual legal battles over intellectual property, patents, privacy and other issues would attest.”

European media are warned: they must seriously raise their legal game if they want to partner with Google — and the agreement signed last Friday in Paris could help.

Having said that, I personally believe it could be immensely beneficial for digital media to partner with Google as much as possible. This company spends roughly two billion dollars a year refining its algorithms and improving its infrastructure. Thousands of engineers work on it. Contrast this with digital media: Small audiences, insufficient stickiness, low monetization plague both web sites and mobile apps; the advertising model for digital information is mostly a failure — and that’s not Google’s fault. The Press should find a way to capture some of Google’s technical firepower and concentrate on what it does best: producing original, high quality contents, a business that Google is unwilling (and probably culturally unable) to engage in. Unlike Apple or Amazon, Google is relatively easy to work with (once the legal hurdles are cleared).

Overall, this deal is a good one. First of all, both sides are relieved to avoid a law (see last Monday Note Google vs. the press: avoiding the lose-lose scenario). A law declaring that snippets and links are to be paid-for would have been a serious step backward.

Second, it’s a departure from the notion of “blind subsidies” that have been plaguing the French Press for decades. Three months ago, the discussion started with irreconcilable positions: publishers were seeking absurd amounts of money (€70m per year, the equivalent of IPG’s members total ads revenue) and Google was focused on a conversion into business solutions. Now, all the people I talked to this weekend seem genuinely supportive of building projects, boosting innovation and also taking advantage of Google’s extraordinary engineering capabilities. The level of cynicism often displayed by the Press is receding.

Third, Google is changing. The fact that Eric Schmidt and Larry Page jumped in at the last minute to untangle the deal shows a shift of perception towards media. This agreement could be seen as a template for future negotiations between two worlds that still barely understand each other.

frederic.filloux@mondaynote.com

iPad Pro: The Missing Workflow

 

The iPad started simple, one window at a time, putting it in the “media consumption” category as a result. Over time, such category proved too narrow, the iPad did well in some content creation activities. Can the new 128 GB iPad continue the trend and acquire better workflow capabilities?

Last week, without great fanfare, Apple announced a new 128 GB version of its fourth generation iPad, a configuration popularly known as the “iPad Pro“. The “Pro” monicker isn’t official, but you wouldn’t know that from Apple’s press release:

Companies regularly utilizing large amounts of data such as 3D CAD files, X-rays, film edits, music tracks, project blueprints, training videos and service manuals all benefit from having a greater choice of storage options for iPad. 

Cue the quotes from execs at seriously data storage-intense companies such as AutoCAD; WaveMachine Labs (audio software); and, quirkily, Global Aptitude, a company that makes film analysis software for football teams:

“The bottom line for our customers is winning football games, and iPad running our GamePlan solution unquestionably helps players be as prepared as possible,” said Randall Fusee, Global Apptitude Co-Founder. 

The naysayers grumble: Who needs this much memory on a “media tablet”? As Gizmodo put it:

The new iPad has the same retina display as its brothers, and the same design, and the same guts, with one notable exception: a metric crap-ton of storage. More storage than any decent or sane human being could ever want from a pure tablet…

(Increased storage is…indecent? This reminds me of the lambasting Apple received for putting 1 — one! — megabyte of memory in the 1986 Mac Plus. And we all recall Bill Gates’ assertion that 640 Kbytes ought to be enough for anyone. He now claims that the quote is apocryphal, but I have a different recollection.)

Or maybe this is simply Apple’s attempt to shore up the iPad’s average selling price ($467, down 18% from the year ago quarter), which took a hit following the introduction of the lower-priced iPad mini. (What? Apple is trying to make more money?)

The critics are right to be skeptical, but they’re questioning the wrong part of the equation.

When we compare iPad prices, the Pro is a bargain, at least by Apple standards:

The jump from 16GB to 32GB costs $100. Another doubling to 64GB costs the same $100. And, on February 5th, you’ll get an additional 64GB for yet another mere $100. (By comparison, extra solid state storage on a MacBook costs between $125 and $150 per 64GB.)

We get a bit more clarity when we consider the iPad’s place in Apple’s product line: As sales of the Mac slow down, the iPad Pro represents the future. Look at Dan Frommer’s analysis of 10 years of Mac sales. First, the Mac alone:

This leads Dan to ask if the Mac has peaked. Mac numbers for the most recent quarter  were disappointing. The newer iMacs were announced in October, with delivery dates in November and December for the 21.5″ and 27″ models respectively. But Apple missed the Xmas quarter window by about a million units, which cut revenue by as much as $1.5B and margin by half a billion or so (these are all very rough numbers). We’ll probably never find out how Apple’s well-oiled Supply Chain Management machine managed to strip a gear, but one can’t help wonder who will be exiled to Outer Mongolia Enterprise Sales.

Now consider another of Dan Frommer’s graphs:

This is units, not revenue. Mac and iPad ASPs are a 3 to 1 ratio but, still, this paints a picture of a slow-growth Mac vs. the galloping iPad.

The iPad — and tablets in general — are usurping the Mac/PC space. In the media consumption domain, the war is all but won. But when we take a closer look at the iPad “Pro”, we see that Apple’s tablet is far from realizing its “professional” potential.

This is where the critics have it wrong: Increased storage isn’t “insane”, it’s a necessary element…but it isn’t sufficient.

For example, can I compose this Monday Note on an iPad? Answering in the affirmative would be to commit the Third Lie of Computing: You Can Do It. (The first two are Of Course It’s Compatible and Chief, We’ll be in Golden Master by Monday.)

I do research on the Web and accumulate documents, such as Dan Frommer’s blog post mentioned above. On a PC or Mac, saving a Web page to Evernote for future reference takes a right click (or a two finger tap).

On an iPad, things get complicated. The Share button in Safari gives me two clumsy choices: I can mail the page to my Evernote account, or I can Copy the URL, launch Evernote, paste the URL, compose a title for the note I just created, and perhaps add a few tags.

Once I start writing, I want to look through the research material I’ve compiled. On a Mac, I simply open an Evernote window, side-by-side with my Pages document: select, drag, drop. I take some partial screenshots, annotate graphs (such as the iPad Pro prices above), convert images to the .png format used to put the Monday Note on the Web…

On the iPad, these tasks are complicated and cumbersome.

For starters — and to belabor the obvious — I can’t open multiple windows. iOS uses the “one thing at a time” model. I can’t select/drag/drop, I have to switch from Pages to Evernote or Safari, select and copy a quote, and then switch back to the document and paste.

Adding a hyperlink is even more tortuous and, at times, confusing. I can copy a link from Safari, switch back to Pages, paste…but I want to “slide” the link under a phrase. I consult Help, which suggests that I tap on the link, to no avail. If I want to attach a link to a phrase in my document, I have to hit the Space key after pasting, go to Settings and then enter the text that will “cover” the link — perfectly obvious.

This order of operations is intuitively backwards. On a Mac (or PC), I select the target text and then decide which link to paste under it.

Things get worse for graphics. On the iPad, I can’t take a partial screenshot. I can take a full screenshot by simultaneously pressing the Home and Sleep buttons, or I can tap on a picture in Safari and select Save. In both cases, the screenshot ends up in the Photos app where I can perform some amount of cropping and enhancing, followed by a Copy, then switch back to Pages and Paste into my opus.

Annotations? No known way. Control over the image file format? Same answer. There’s no iPad equivalent to the wonderful Preview app on the Mac. And while I’m at it, if I store a Preview document in iCloud, how do I see it from my iPad?

This gets us into the more general — and “professional” — topic of assembling a trove of parts that can be assembled into a “rich” document, such as a Keynote presentation. On a personal computer, there are plenty of choices. With the iPad, Apple doesn’t provide a solution, there’s no general document repository, no iCloud analog to Dropbox or Microsoft’s Skydrive, both of which are simple to use, quasi-free and, in my experience, quite reliable. (One wonders: Is the absence of a Dropbox-like general documents folder in iCloud a matter of technology or theology?)

Simply throwing storage at the problem is, clearly, not enough to make the iPad a “Pro” device.  But there is good news. Some of it is anecdotal, such as the more sophisticated editing provided by the iPad version of iPhoto. The better news is that iOS is a mature, stable operating system that takes advantage of fast and spacious hardware.

But the best news is that Apple has, finally, some competition when it comes to User Experience. For example, tablets that run Microsoft or Google software let users slide the current window to show portions of another one below, making it easier to select parts of a document and drop them into another. (Come to think of it, the sliding Notifications “drawer” on the iPad and iPhone isn’t too far off.)

This competition might spur Apple to move the already very successful iPad into authentically “Pro” territory.

The more complex the task, the more our beloved 30-year-old personal computer is up to it. But there is now room above the enforced simplicity that made the iPad’s success for UI changes allowing a modicum of real-world “Pro” workflow on iPads.

JLG@mondaynote.com

Dell Buyout: Microsoft’s Generosity

 

To perform painful surgery on its business model, Dell needs to take the company private. Seeing challenges in raising the needed $22B, Microsoft “generously” proposes to contribute a few billions. Is this helping or killing the deal?

The news broke two weeks ago: Dell wants to go private. The company would like to buy back all of its publicly traded shares.

The Apple forums are abuzz with memories of Michael Dell’s dismissal of Steve Jobs’ efforts to breathe new life into Apple in 1997:

What would I do? I’d shut it down and give the money back to the shareholders.

Is it now Michael’s turn to offer a refund?

Now we hear that Microsoft wants to lend a hand, as in “several billion dollars”. The forums buzz again: It’s just like when Bill Gates came to Jobs’ rescue and invested $150M in the Cupertino company, thus avoiding a liquidity crisis.

The analogy is amusing but facile. Dell 2013 isn’t Apple 1997. A look at Dell’s latest financials shows that the company still enjoys a solid cash position ($14B) and a profitable business (3.5% net profit margin). It’s profits may not be growing (-11% year to year), but the company is cash-flow positive nonetheless ($1.3B from the latest quarter). There’s no reason to fold up the tents.

As for Microsoft’s involvement: The Redmond company’s “investment” in Apple was part of a settlement of an on-going IP dispute. Microsoft avoided accusations of monopoly by keeping alive a highly visible but not overly dangerous adversary.

So what is Dell trying to accomplish by going private? To answer the question, let’s step back a bit and explore the whys and hows of such a move.

First, we have the Management Buyout. Frustrated with Wall Street’s low valuation, executives buy back their company “on the cheap” and run it in private for their own benefit. This rarely ends well.  Second-guessing the market is never a good idea, and the enormous amount of money that’s needed to pay off shareholders puts the execs at the mercy of bigger, smarter predators who turn out to be the ones who end up running the company for their benefit.

A good reason for going private is to allow a company to shift to a radically different business model without being distracted by Wall Street’s annoying glare and hysterics. This is what Dell is trying to do. They’re not shutting down shop, they’re merely closing the curtain.

Is it necessary to privatize for such a move? For an example that never came to pass, recall Bill Gates’ suggestion, in 1985, that Apple should get out of the hardware business and, instead, license the Mac operating system. At the time, the average revenue per Mac exceeded $2,500; a putative Mac OS license would have sold for $100. The theory was that Apple would eventually sell many, many more OS licenses than it did Macs.

The pundits agreed: “Just look at Microsoft!”.  Apple would jump from one slowly ascending earnings curve to a much steeper one.

Now picture yourself as John Sculley, Apple CEO, going to Wall Street with the following message: “We heard you, we’ve seen the light. Today, we’re announcing a new era for our company, we’ll be licensing Mac OS licenses to all comers for $100 apiece. Of course, there’ll be a trough; licensing revenue won’t immediately compensate the loss of Mac hardware sales. We need am ‘earnings holiday’ of about 36 months before the huge software profits flow in.”

You just became the ex-CEO. Wall Street dumps your shares, effectively telling you to take them back and only return after your “holiday” is over.

As another example that didn’t happen but probably should have, imagine if Nokia CEO Stephen Elop had taken his company private in 2011. Instead of osborning its Symbian business, Nokia would have had the latitude to perform the OS gender change behind closed doors and reemerge with a shiny new range of Microsoft-powered smartphones.

I’ll hasten to add that these made-up examples are somewhat unrealistic: To engineer a buyout, one must raise amounts of money commensurate with the company’s current valuation. Around 1987, Apple was worth about $2B, a great deal of money a quarter of century ago. In early 2011, Nokia’s market capitalization was about $40B, an impossibly large sum.

Still, thanks to these buyout fantasies, we get the two key ideas: First, Dell wants to go private because it plans to alter its business model in ways that would scare nervous, short-term Wall Street shareholders; second, the required amount of money (Dell’s market cap is about $22B) is a potential deal-killer.

We don’t have to look very far for the changes Dell wants to make. Dell no longer likes its legacy PC business and has made efforts to reposition itself as an enterprise player (expensive iron, software and services). Going private will allow it to perform the needed surgery, stanch the bleeding, and reemerge with a much stronger income statement, rid of low-margin commodity PCs.

When we look at the money that needs to be raised, things become really interesting. Michael Dell’s 15.7% ownership of the company undoubtedly helps, but the $22B market cap is still a big hill to climb. Several buyout firms and banks got involved in preliminary discussions; one group, TPG Capital, dropped out, but another, Silver Lake, has persisted in its attempt to round up big banks and other investors with enough funds to vacuum up Dell’s publicly traded shares.

That’s when Microsoft walks in on the discussions and offers to save Private Dell.

Clearly, Microsoft’s money will help in the buyout…but will its involvement torpedo Dell’s intentions? The NY Times DealBook article makes the case for Microsoft propping up the leading PC maker:

A vibrant Dell is an important part of Microsoft’s plans to make Windows more relevant for the tablet era, when more and more devices come with touch screens.

This would give Microsoft some amount of control over the restructured Dell, a seat on the Board of Directors, perhaps, with ways to better align the PC maker’s hardware with Redmond’s software. Microsoft wants Dell’s reinvigorated participation in the “Windows Reimagined” business.

But note the phrasing above: “Dell is an important part of Microsoft’s plans…” Better vertical integration without having to pay the full price for ownership, the putative “several billion dollars” would give Microsoft a significant ownership, 10% or 15%. This is completely at odds with the buyout’s supposed intent: Getting out of the PC clone race to the bottom.

Or maybe there’s another story behind Microsoft’s beneficence: The investor syndicate struggles and can’t quite reach the $22B finish line. Microsoft generously — and very publicly — offers to contribute the few missing billions. Investors see Microsoft trying to reattach the PC millstone to their necks — and run away.

Hats off to Steve Ballmer: Microsoft looks generous – without having to spend a dime – and forces Dell keep making PCs.

JLG@mondaynote.com

Google vs. the press: avoiding the lose-lose scenario

 

Google and the French press have been negotiating for almost three months now. If there is no agreement within ten days, the government is determined to intervene and pass a law instead. This would mean serious damage for both parties. 

An update about the new corporate tax system. Read this story in Forbes by the author of the report quoted below 

Since last November, about twice a week and for several hours, representatives from Google and the French press have been meeting behind closed doors. To ease up tensions, an experienced mediator has been appointed by the government. But mistrust and incomprehension still plague the discussions, and the clock is ticking.

In the currently stalled process, the whole negotiation revolves around cash changing hands. Early on, representatives of media companies where asking Google to pay €70m ($93m) per year for five years. This would be “compensation” for “abusively” indexing and linking their contents and for collecting 20 words snippets (see a previous Monday Note: The press, Google, its algorithm, their scale.) For perspective, this €70m amount is roughly the equivalent to the 2012 digital revenue of newspapers and newsmagazines that constitutes the IPG association (General and Political Information).

When the discussion came to structuring and labeling such cash transfer, IPG representatives dismissively left the question to Google: “Dress it up!”, they said. Unsurprisingly, Google wasn’t ecstatic with this rather blunt approach. Still, the search engine feels this might be the right time to hammer a deal with the press, instead of perpetuating a latent hostility that could later explode and cost much more. At least, this is how Google’s European team seems to feel. (In its hyper-centralized power structure, management in Mountain View seems slow to warm up to the idea.)

In Europe, bashing Google is more popular than ever. Not only just Google, but all the US-based internet giants, widely accused of killing old businesses (such as Virgin Megastore — a retail chain that also made every possible mistake). But the actual core issue is tax avoidance. Most of these companies hired the best tax lawyers money can buy and devised complex schemes to avoid paying corporate taxes in EU countries, especially UK, Germany, France, Spain, Italy…  The French Digital Advisory Board — set up by Nicolas Sarkozy and generally business-friendly — estimated last year that Google, Amazon, Apple’s iTunes and Facebook had a combined revenue of €2.5bn – €3bn but each paid only on average €4m in corporate taxes instead of €500m (a rough 20% to 25% tax rate estimate). At a time of fiscal austerity, most governments see this (entirely legal) tax avoidance as politically unacceptable. In such context, Google is the target of choice. In the UK for instance, Google made £2.5bn (€3bn or $4bn) in 2011, but paid only £6m (€7.1m or $9.5m) in corporate taxes. To add insult to injury, in an interview with The Independent, Google’s chairman Eric Schmidt defended his company’s tax strategy in the worst possible manner:

“I am very proud of the structure that we set up. We did it based on the incentives that the governments offered us to operate. It’s called capitalism. We are proudly capitalistic. I’m not confused about this.”

Ok. Got it. Very helpful.

Coming back to the current negotiation about the value of the click, the question was quickly handed over to Google’s spreadsheet jockeys who came up with the required “dressing up”. If the media accepted the use of the full range of Google products, additional value would be created for the company. Then, a certain amount could be derived from said value. That’s the basis for a deal reached last year with the Belgium press (the agreement is shrouded in a stringent confidentiality clause.)

Unfortunately, the French press began to eliminate most of the eggs in the basket, one after the other, leaving almost nothing to “vectorize” the transfer of cash. Almost three months into the discussion, we are stuck with antagonistic positions. The IPG representatives are basically saying: We don’t want to subordinate ourselves further to Google by adopting opaque tools that we can find elsewhere. Google retorts: We don’t want to be considered as another deep-pocketed “fund” that the French press will tap forever into without any return for our businesses; plus, we strongly dispute any notion of “damages” to be paid for linking to media sites. Hence the gap between the amount of cash asked by one side and what is (reluctantly) acceptable on the other.

However, I think both parties vastly underestimate what they’ll lose if they don’t settle quickly.

The government tax howitzer is loaded with two shells. The first one is a bill (drafted by no one else than IPG’s counsel, see PDF here), which introduces the disingenuous notion of “ancillary copyright”. Applied to the snippets Google harvests by the thousands every day, it creates some kind of legal ground to tax it the hard way. This montage is adapted from the music industry in which the ancillary copyright levy ranges from 4% to 7% of the revenue generated by a sector or a company. A rate of 7% for the revenue officially declared by Google in France (€138m) would translate into less than €10m, which is pocket change for a company that in fact generates about €1.5 billion from its French operations.

That’s where the second shell could land. Last Friday, the Ministry of Finances released a report on the tax policy applied to the digital economy  titled “Mission d’expertise sur la fiscalité de l’économie numérique” (PDF here). It’s a 200 pages opus, supported by no less than 600 footnotes. Its authors, Pierre Collin and Nicolas Colin are members of the French public elite (one from the highest jurisdiction, le Conseil d’Etat, the other from the equivalent of the General Accounting Office — Nicolas Colin being  also a former tech entrepreneur and a writer). The Collin & Colin Report, as it’s now dubbed, is based on a set of doctrines that also come to the surface in the United States (as demonstrated by the multiple references in the report).

To sum up:
– The core of the digital economy is now the huge amount of data created by users. The report categorizes different types of data: “Collected Data”, are  gathered through cookies, wether the user allows it or not. Such datasets include consumer behaviors, affiliations, personal information, recommendations, search patterns, purchase history, etc.  “Submitted Data” are entered knowingly through search boxes, forms, timelines or feeds in the case of Facebook or Twitter. And finally, “Inferred Data” are byproducts of various processing, analytics, etc.
– These troves of monetized data are created by the free “work” of users.
– The location of such data collection is independent from the place where the underlying computer code is executed: I create a tangible value for Amazon or Google with my clicks performed in Paris, while the clicks are processed in a  server farm located in Netherlands or in the United Sates — and most of the profits land in a tax shelter.
– The location of the value insofar created by the “free work” of users is currently dissociated from the location of the tax collection. In fact, it escapes any taxation.

Again, I’m quickly summing up a lengthy analysis, but the conclusion of the Collin & Colin report is obvious: Sooner or later, the value created and the various taxes associated to it will have to be reconciled. For Google, the consequences would be severe: Instead of €138m of official revenue admitted in France, the tax base would grow to €1.5bn revenue and about €500m profit; that could translate €150m in corporate tax alone instead of the mere €5.5m currently paid by Google. (And I’m not counting the 20% VAT that would also apply.)

Of course, this intellectual construction will be extremely difficult to translate into enforceable legislation. But the French authorities intend to rally other countries and furiously lobby the EU Commission to comer around to their view. It might takes years, but it could dramatically impact Google’s economics in many countries.

More immediately, for Google, a parliamentary debate over the Ancillary Copyright will open a Pandora’s box. From the Right to the Left, encouraged by François Hollande‘s administration, lawmakers will outbid each other in trashing the search engine and beyond that, every large internet company.

As for members the press, “They will lose too”, a senior official tells me. First, because of the complications in setting up the machinery the Ancillary Copyright Act would require, they will have to wait about two years before getting any dividends. Two, the governments — the present one as well as the past Sarkozy administration  — have always been displeased with what they see as the the French press “addiction to subsidies”; they intend to drastically reduce the €1.5bn in public aid. If the press gets is way through a law,  according to several administration officials, the Ministry of Finances will feel relieved of its obligations towards media companies that don’t innovate much despite large influxes of public money. Conversely, if the parties are able to strike a decent business deal on their own, the French Press will quickly get some “compensation” from of Google and might still keep most of its taxpayer subsidies.

As for the search giant, it will indeed have to stand a small stab but, for a while, will be spared the chronic pain of a long and costly legislative fight — and the contagion that goes with it: The French bill would be dissected by neighboring governments who will be only too glad to adapt and improve it.

frederic.filloux@mondaynote.com   

Next week: When dealing with Google, better use a long spoon; Why European media should rethink their approach to the search giant.

iPhone Low-cost Numbers

 

For years, Apple’s been told its products were too expensive – and prospered mightily. Today, many suggest Apple should launch a low-cost iPhone. Will history repeat itself, or have the rules of the Smartphone Wars changed in ways that will force Apple to alter its strategy? 

Dismissing the prospect of a Low Cost iPhone isn’t all that difficult. Just look at Apple’s history. For years, the high tech pundits have hectored Apple for it’s inability to see the wisdom of the cheap. In the late eighties and into the nineties, they insisted that a low cost Mac was the only way the company could survive against the swarm of PC clones. Steve Jobs returned and righted the Apple ship, no LC Mac required.

A decade later, the netbook was cast as the killer torpedo that would sink the resurgent Mac business. Jobs famously dismissed the netbook as a cheap plastic device Apple would never stoop to make: “We don’t know how to build a sub-$500 computer that is not a piece of junk.”

At the September 2012 iPhone 5 launch, Tim Cook announced that the MacBook is the #1 selling notebook in the US (5:30 into this video). Couple that with the success of the iPad, and the netbook is dead. And thus, by analogy, there will be no iPhone LC. Apple doesn’t do cheap. The company will focus on a premium customer experience and enjoy a high profit margin. The race to the bottom will be left to Android clones. Move along, nothing to see.

Not so fast.

Using Apple’s history — and particularly the sorry netbook story — to dismiss the iPhone LC makes questionable assumptions. As Marx (Karl, not Groucho) liked to say: ‘History doesn’t repeat itself, it stutters’. Smartphones aren’t PCs, only smaller; the rules of the Macintosh game don’t apply to the iPhone. The Smartphone Wars are waged by markedly different laws, and are waged well by Google and Samsung, unencumbered by a PC past.

But let’s back up: What would a Low Cost iPhone look like, whom would it serve, and just how “low” is Low? The easiest way to picture the thing is to drag out your old iPhone 3G or 3GS. A plastic body, an “original-resolution” screen (no Retina here), a slow processor and even slower wireless connection. It’s not today’s iPhone 5, with its metal body, lovingly machined chamfers, Gorilla Glass, high-speed A6 processor, and 5 megapixel camera.

The phone would serve the prepaid market, it addresses customers with little or no credit. Everything is paid for with cash up front: You pay the full, unsubsidized price for the phone and you buy “minutes” (let’s call them units of wireless network utilization) in advance. Buying units for these devices is a simpler experience than I imagined: Go to the neighborhood drugstore, pick out a phone card by a (virtual) carrier such as TracFone, and the cash register prints an activation code you then enter into the phone. Simple, pervasive, and very successful — even in a “rich” country such as the US.

So far, Apple has avoided the prepaid approach. When we give $199 to Verizon for a $650 iPhone, the $450 subsidy is an act of faith by the wireless carrier. The philanthropic organization assumes we’ll pay our bill every month for two years, by which time the carrier has recouped the subsidy. This is the postpaid world that Apple understands.

As for the pricetag, let’s assume that an iPhone LC would cost about $100 to manufacture — that’s half the cost of the basic iPhone 5. If we apply a 60% margin percentage — the same as today’s iPhone 5 — the unsubsidized iPhone LC would sell for $299.

That’s too high. Let’s try lower numbers: 50% margin gets us down to $199; 30% to $149. To get to the magic $99 unsubsidized retail, with an un-Apple 30% margin, the iPhone LC would need to be manufactured for less than $75, about one third of today’s iPhone 5.

And even $99 may not be low enough. Go to Amazon and look for prepaid cell phones. The first models start at $6.99 (not recommended, I tried one at $8.99 for my visiting Mother-in-Law, that was a mistake). Real smartphones running Android 2.2 start at $49.99 – today! For another $10 you get 2.3. The $80.73 Kyocera Rise runs the much more modern 4.0 (Ice Cream Sandwich) version. (I checked prepaid prices in other countries and the situation is similar.)

In his earnings release conference calls, Tim Cook constantly refers to Apple’s interest in the vast prepaid market segment but so far it’s been all talk. The reason for the gap between words and deeds sits in plain view on Amazon’s prepaid cell phone page. As more devices enter the market, we can only imagine what the page will look like a year from now.

The prepaid market, without carrier subsidies, is already in a PC-like race to the bottom. For Apple to enter and prosper in this segment, it has to determine two things: What sort of premium can it get for a low cost iPhone, and what would the device mean for the rest of the product line?

Apple execs are fond of saying they’d cannibalize their products themselves rather than let competitors do it. Even if exquisitely executed and priced just so, it’s hard not to see the (putative) iPhone LC as the augur of a new era of lower Apple margins. In other words, the iPhone LC wouldn’t be born of a tactical decision to add a new set of customers, it would be a strategic move that signals a new phase in the Smartphone Wars.

Apple loves to control the game. So do Google, Microsoft, Samsung, and everyone else, of course, but Apple’s love is an unusually intense, deeply seated drive that stems from Steve Jobs’ own (carnal as opposed to deliberate) need to master and direct every aspect of the game.

In the PC business, Jobs pushed vertical integration down beyond hardware and software, and into its retail chain of Apple Stores, thus ensuring a tightly controlled delivery of the product experience. The same applied to the iPod and its integration with iTunes. The well-controlled media delivery and novel micro-payment system was a huge win: In 2006 iPod revenue outpaced the Macintosh line.

The iPhone started with Apple fully in control. AT&T stood aside and let Apple run the table, handle all aspects of the customer experience (except for call quality). Later, the App Store extended Apple’s control of the game. The iPhone became an app phone and a phenomenal success.

(We also have the counterexample of Apple TV, an exception that proves the rule. TV content owners, distributors, and carriers haven’t let the Cupertino company seize control of the customer experience, and thus Apple TV remains a “hobby”.)

Apple is still in control of its iPhone ecosystem… but things have changed. Now the company faces Google and Samsung. Google isn’t just Android, it’s also a provider of a wide set of services such a Google Maps, Gmail, Google Docs and Drive, Google Voice, and on and on. Samsung is more vertically integrated, makes its own smartphones components, and spends more marketing money ($13B last year) than anyone else.

In today’s smartphone scene, can Apple still enjoy the control — and the ensuing profit potential — it craves? And if not, how will it react? Tactics or strategy?

JLG@mondaynote.com

Linking: Scraping vs. Copyright

 

Irish newspapers created quite a stir when they demanded a fee for incoming links to their content. Actually, this is a mere prelude to a much more crucial debate on copyrights,  robotic scraping and subsequent synthetic content re-creation from scraps. 

The controversy erupted on December 30th, when an attorney from the Irish law firm McGarr Solicitors exposed the case of one of its client, the Women’s Aid organization, being asked to pay a fee to Irish newspapers for each link they send to them. The main quote from McGarr’s post:

They wrote to Women’s Aid, (amongst others) who became our clients when they received letters, emails and phone calls asserting that they needed to buy a licence because they had linked to articles in newspapers carrying positive stories about their fundraising efforts.
These are the prices for linking they were supplied with:

1 – 5 €300.00
6 – 10 €500.00
11 – 15 €700.00
16 – 25 €950.00
26 – 50 €1,350.00
50 + Negotiable

They were quite clear in their demands. They told Women’s Aid “a licence is required to link directly to an online article even without uploading any of the content directly onto your own website.”

Recap: The Newspapers’ agent demanded an annual payment from a women’s domestic violence charity because they said they owned copyright in a link to the newspapers’ public website.

Needless to say, the twittersphere, the blogosphere and, by and large, every self-proclaimed cyber moral authority, reacted in anger to Irish newspapers’ demands that go against common sense as well as against the most basic business judgement.

But on closer examination, the Irish dead tree media (soon to be dead for good if they stay on that path) is just the tip of the iceberg for an industry facing issues that go well beyond its reluctance to the culture of web links.

Try googling the following French legalese: “A défaut d’autorisation, un tel lien pourra être considéré comme constitutif du délit de contrefaçon”. (It means any unauthorized incoming link to a site will be seen as a copyright infringement.) This search get dozens of responses. OK, most come from large consumers brands (carmakers, food industry, cosmetics) who don’t want a link attached to an unflattering term sending the reader to their product description… Imagine lemon linked to a car brand.

Until recently, you couldn’t find many media companies invoking such a no-link policy. Only large TV networks such as TF1 or M6 warn that any incoming link is subject to a written approval.

In reality, except for obvious libel, no-links policies are rarely enforced. M6 Television even lost a court case against a third party website that was deep-linking to its catch-up programs. As for the Irish newspapers, despite their dumb rate card for links, they claimed to be open to “arrangements” (in the ill-chosen case of a non-profit organization fighting violence against women, flexibility sounds like a good idea.)

Having said that, such posture reflects a key fact: Traditional media, newspapers or broadcast media, send contradictory messages when it comes to links that are simply not part of their original culture.

The position paper of the National Newspapers of Ireland association’s deserves a closer look (PDF here). It actually contains a set of concepts that resonate with the position defended by the European press in its current dispute with Google (see background story in the NYTimes); here are a few:

– It is the view of NNI that a link to copyright material does constitute infringement of copyright, and would be so found by the Courts.
– [NNI then refers to a decision of the UK court of Appeal in a case involving Meltwater Holding BV, a company specialized in media monitoring], that upheld the findings of the High Court which findings included:
- that headlines are capable of being independent literary works and so copying just a headline can infringe copyright
- that text extracts (headline plus opening sentence plus “hit” sentence) can be substantial enough to benefit from copyright protection
- that an end user client who receives a paid for monitoring report of search results (incorporating a headline, text extract and/or link, is very likely to infringe copyright unless they have a licence from the
Newspaper Licencing Agency or directly from a publisher.
– NNI proposes that, in fact, any amendment to the existing copyright legislation with regard to deep-linking should specifically provide that deep-linking to content protected by copyright without respect for  the linked website’s terms and conditions of use and without regard for the publisher’s legitimate commercial interest in protecting its own copyright is unlawful.

Let’s face it, most publishers I know would not disagree with the basis of such statements. In the many jurisdictions where a journalist’s most mundane work is protected by copyright laws, what can be seen as acceptable in terms of linking policy?

The answer seems to revolve around matters of purpose and volume.

To put it another way, if a link serves as a kind of helper or reference, publishers will likely tolerate it. (In due fairness, NNI explicitly “accepts that linking for personal use is a part of how individuals communicate online and has no issue with that” — even if the notion of “personal use” is pretty vague.) Now, if the purpose is commercial and if linking is aimed at generating traffic, NNI raises the red flag (even though legal grounds are rather brittle.) Hence the particular Google case that also carries a notion of volume as the search engine claims to harvest thousands of sources for its Google News service.

There is a catch. The case raised by NNI and its putative followers is weakened by a major contradiction: everywhere, Ireland included, news websites invest a great deal of resources in order to achieve the highest possible rank in Google News. Unless specific laws are voted (German lawmakers are working on such a bill), attorneys will have hard time invoking copyright infringements that in fact stem for the very Search Engine Optimization tactics publishers encourage.

But there might be more at stake. For news organizations, the future carries obvious threats that require urgent consideration: In coming years, we’ll see great progress — so to speak — in automated content production systems. With or without link permissions, algorithmic content generators will be able (in fact: are) to scrap sites’original articles, aggregate and reprocess those into seemingly original content, without any mention, quotation, links, or reference of any kind. What awaits the news industry is much more complex than dealing with links from an aggregator.

It boils down to this: The legal debate on linking as copyright infringement will soon be obsolete. The real question will emerge as a much more complex one: Should a news site protect itself from being “read”  by a robot? The consequences for doing so are stark: except for a small cohort of loyal readers, the site would purely and simply vanish from cyberspace… Conversely, by staying open to searches, the site exposes itself to forms of automated and stealthy depletion that will be virtually impossible to combat. Is the situation binary — allowing “bots” or not — or is there middle ground? That’s a fascinating playground for lawyers and techies, for parsers of words and bits.

frederic.filloux@mondaynote.com

2013: The Year Of…

 

As Samsung dominates the Android market, one has to wonder, who controls whom? Is Google really in charge, or is Samsung so strong it can now rule the Android game?

This morning’s thoughts are harder to focus than usual: I’m sitting across the street from Sciences Po — the Paris Institute of Political Studies — one of France’s elite graduate schools. As hundreds of students gather at the door, smoking (and littering the pavement with very Parisian hauteur), I’m dismayed by the thought that many of these smart, eagerly alive young people will die from lung cancer. Somber thoughts made more acute by the loss of a dear friend two days ago to that very illness — the third smoking-induced death of a close relation in a matter of months. This from a legal drug that’s much more dangerous than some that can land you in jail….

Back to less morbid topics: Like so many other high tech observers, the impending CES (Consumer Electronics Show) in Las Vegas has prompted me to take a guess at what — or who — will turn out to be 2103′s most important development. One name that isn’t on the list: Microsoft.

CES isn’t just an endless series of booths manned by barkers and BS artists where companies peddle their latest vacuum tube audio gear and touch-screen laptops, it’s also the venue for a conference with a series of keynote speeches. During the Golden Age of the PC, Bill Gates was the obligatory headliner on the eve of the trade show. Gates’ keynote was an opportunity for the head of the world’s most important software company to describe (and prescribe) the future according to Microsoft.

When he ceded the CEO title, Gates also passed the keynote baton to Steve Ballmer who continued the propaganda, although with progressively diminishing success. Last year’s keynote was widely trashed by the press (see here, here or here)

Microsoft CEO crashes and burns in final CES keynote.
At CES, Microsoft’s Steve Ballmer Strains For Relevance

There will be no keynote address from Ballmer or any other Microsoft representative at this year’s CES.
The baton has indeed been passed, but to whom?
The ascendancy will be decided in a fight between Google and Samsung — and that could turn out to be the most important 2013 development.

Samsung is, by far, the biggest promoter and the best advertisement for the Android platform. Not only does the Korean giant dominate the Android market in unit volume — about half if we believe the company’s necessarily imprecise numbers — it also sets the standard for quality with handsets such as the Galaxy S III. And when you consider the huge amount of money Samsung has spent promoting their devices (about $13B — see Horace Dediu’s chart, below, from yet another of illuminating posts, The Cost of Selling Galaxies), you would think that the two companies would be close allies.

But as Samsung dominates ever more of the Android market, one has to wonder: Who controls whom? Is Google really in charge, or is Samsung so strong it can now set the rules in the Android game?

I don’t think Samsung’s competitors fully appreciate the implications of the company’s spare-no-expense investment in securing a dominant market share. In particular, I wonder what Apple execs think of the disproportion between their own relatively tiny marketing expenses and Samsung’s gargantuan budget. Apple has shown, time and again, that they can do more with less, but have they let Samsung secure an inexpugnable market position? Perhaps the Cupertino team was simply unwilling to waste money stimulating a demand they knew they couldn’t satisfy due to iPhone supply chain bottlenecks.

Is Google truly happy with all this free advertisement? Samsung is firing on all cylinders: great Android handsets, apparently limitless manufacturing capacity, imaginative and prolific marketing campaigns. There may be a feeling in Mountain View that the tail is starting to wag the dog, the handset vassal could end up dictating terms to the platform creator. Samsung could parlay its dominant share of Android handsets in a number of ways.

For example: The Android economy doesn’t rely on licensing revenues but on user data that flows back to the Google mothership through the use of Google applications running on platform-compliant handsets. (Such data then flows through Google’s advertising money pump, but we’ll leave that aside for now.) What if Samsung could renegotiate its Android license and demand “role-appropriate” levies for running Google apps on its market-leading handsets? We’ve heard rumors of just such a levy before: Apple is said to receive significant payments for favoring Google’s search engine in iOS devices.

Another possibility is that Samsung could emulate Amazon’s practice of picking the Android lock. By modifying the Open Source Android source code — a completely legal maneuver — Samsung could create its own set of revenue-generating apps and services and thus cut Google out of the income stream. A number of other handset makers, particularly in China, are headed down this path, proposing devices based on Android-derived platforms such as Tapas and OPhone.

Lastly, although less seriously, Samsung has announced handsets based on Tizen, an OS that has joined the chorus line of Open Source platforms: Gram (née WebOS), Jolla (Nokia émigrés), Ubuntu (née Debian), Firefox OS. My apologies for possible oversights…

Samsung can’t possibly believe it can build a viable business on Tizen. It must know that the platform itself no longer matters, that this has become an ecosystem war. Even with Samsung’s resources and determination, betting on Tizen as an alternative to the Android ecosystem isn’t realistic — and can’t possibly impress Google execs. Complicating matters, Samsung also builds handsets on Windows Phone and Bada (developed in house). Such complexity isn’t sustainable.

Over in its corner, Google has Motorola. Ostensibly acquired for its patents, Motorola could    be the piece of the puzzle that Google needs to create a fully-integrated device, a “proper” Android handset that Google execs feel their ecosystem deserves and that independent handset makers have failed to deliver. Rumors of an xPhone are in the air, but they don’t say much about what the product will do, exactly, or when it will come out.(Google protests that it won’t give its Motorola team any unfair advantage…a promise that comes from a company that gives special access to partners-of-the-moment such as HTC, Samsung, and LG.)

Of course, creating a device in the numbers that can effectively compete with leading Samsung (and Apple) devices is easier said than done. Google/Motorola will need to convince component suppliers and device manufacturers — who are “controlled” by Samsung and Apple — to free up some space on their assembly lines.

So on one side, we have Samsung, an extremely capable and determined Korean giant with huge technical and financial resources — and little regard for niceties.

On the other, we have Google with its unparalleled infrastructure, full control of the Android ecosystem through its Google apps (think Maps) and services, very strong finances, and real long-term vision. As for niceties, Google’s style may be more “polished” than Samsung’s, but it isn’t a pushover. Google can stand toe-to-toe with anyone.

In the end, ownership of the ecosystem should tip the scales: Google will win the undeclared war with Samsung. The Mountain View company will help itself to the higher value of vertically integrated products and, at best, degrade the Korean giant’s margins or, worse, drive them into a PC-like race-to-the-bottom with other handset makers.

This isn’t an outcome Samsung will take lightly.

JLG@mondaynote.com

PS: Bill Clinton will attend Samsung’s CES keynote

Mobile’s Rude Awakening

 

Mobile audiences are large and growing. Great. But their monetization is mostly a disaster. The situation will be slow to improve, but the potential is still there — if the right conditions are met.    

This year, a major European newspaper expects to make around €16m in digital advertising revenue. The business is even slightly profitable. But there is a catch: while mobile devices now provide more than 50% of its traffic, advertising revenue from smartphones and tablets will only reach €1m. For this particular company, like many others, mobile advertising doesn’t work. It brings about 5% or 6% of what desktop web ads do — which, already, suffer from a 15 times cut in revenue when compared to print.

Call it a double whammy: Publishers took a severe hit by going digital in a way that compounded commoditization of contents with an endless supply of pages. The result is economically absurd: in a “normal” world, when audiences rise, advertising reaches more people and, as a result, rates rise. At least, that was the rule in the comfy world of print. No such thing in digital media. As many news sites experienced, despite double digit audience growth, CPMs (Cost per Thousand page impressions) actually declined over recent years. Fact is, this sector is much more sensitive to general economic conditions than to its extraordinary large adoption. And as if that wasn’t enough, publishers now take another blow as a growing share of their audience moves to mobile where money hasn’t followed… yet.

Granted, there are exceptions. Nordic media, for instance, benefit from an earlier and stronger mobile adoption (think Nokia and Ericsson, even before smartphones). Supported by many paid-for services, Scandinavian media houses extract a significant amount of profit from mobile. Similarly, Facebook mobile operations are faring quite well. According to the latest TBG Digital report, Click Through Rate (CTR) on ads placed on mobile News Feeds are 23 times higher than those displayed on the desktop version (respectively a CTR of 1.290% vs. 0.049%).

The digital mediasphere is struggling with mobile ads. In June, we went through most of the causes (see Jean-Louis’ note Mobile Advertising: The $20bn Opportunity Mirage). Problem is: there are still few signs of improvement. Inventories are growing, ad creativity remains at a low point (just look at the pixelated ads that plague the bottom of your mobile screens). As you can see below, programmatic buying is on the rise as this low-yield market remains vastly intermediated (click to enlarge):

– Too many middlemen? –

This results in the following eCPMs (effective CPM is the price advertisers are willing to pay for a given audience) as surveyed for different mobile platforms:

iOS iPad........... $0.90-$1.10
iOS iPhone......... $0.70-$0.80
Android Tablet..... $0.60-$0.70
Android Phones..... $0.40-$0.60

Advertising-wise, mobile is mostly a dry hole.

OK. Enough whining. Where do we go from here? What to expect in the next 18 months? How to build upon the inherent (and many) advantages offered by the mobile space?

For rate cards, we have some good news: prices on Android and iOS are converging upward as Android demographics are rising; soon, the two dominant mobile platforms will be in the higher price range. The value of ads is also likely to climb a little as screens gets better and larger, and as bandwidth increases: such improvements will (should) allow more visually attractive, more engaging ads. The ecosystem should also benefit from the trend toward more customized advertising. Ideally, promotional campaigns should be completely integrated and provide a carefully designed continuum within the three digital vectors: desktop web to be viewed at home or at the office; mobile formats for quick reading on the go; and tablet-friendly for a slower, more engaged, lean-back consumption (reading time is five or ten times higher on an iPad than on a PC). But, again, as long as creative agencies or media themselves do not commit adequate resources to such a virtuous chain, the value created will stay dangerously close to zero. (Those players better hurry up as a myriad of agile startups are getting ready to take control of this neglected potential.)

A few more reasons for being bullish on mobile. For instance, the level of personalization has nothing to do with what we see on the PC; a smartphone is not shared; it’s personal; and it’s the best vector to carry an intimate environment in which to create one’s dedicated social interaction system, transactional tools, entertainment selections (games, movies, books, TV series), etc. Mobile devices come with other, high potential features such as geolocation, ability to scan a bar-code — all favoring impulse buying. (This happened to me more than once: In a Paris bookstore, if the only copy left of a book I want is worn-off, or if the salesperson seems annoyed by my mere presence, I quickly scan the bare-code and order it from Amazon on the spot, right from the store. Apparently, I’m not the only one: about 20% of mobile users admitted they scanned a bar-code, or took a picture of a product in a store). And soon, these features will be supplemented by electronic wallet functions. Think about it: which marketeer wouldn’t dreamed of having access to such capabilities?

frederic.filloux@mondaynote.com

Whitman: One Write-Off Too Far

 

Meg Whitman’s efforts to turn HP around follow a proven script. But, in her efforts to frame future results against a background of past misdeeds, she might have gone one excuse too far and engaged in a potentially embarrassing fight against Mike Lynch, Autonomy’s founder.

Turnaround Artist Manual – Chapter 1: Walk in with a frown; blame your predecessor; slash projects, budgets, people; lower expectations, loudly; and write off assets.

When you’re finished, any progress going forward will be attributed to your decisive surgery and skill at the helm. You reap the benefits of a statistical illusion: Cut something by 50%, use time, work, and a little bit of luck to bring it back to its pre-surgery size, and you’re a miracle worker! 100% growth!

When Meg Whitman became HP’s CEO in September 2011, she followed the manual to the letter, and how!

Whitman had more than one predecessor to blame: Leo Apotheker was culpable for sins that we’ll review in a moment; Mark Hurd for acquiring EDS for $13.9B, for starving R&D down to less than 2.5% of revenue, and for the ill-fated $1.2B Palm acquisition. For good measure, Whitman included Carly Fiorina in her “rotating cast of CEOs” who were at fault for their “multiple inconsistent strategic plans and executional miscues“.

Then we have the HP layoffs. Early in 2012, Meg projected 27,000 layoffs through 2014, a number that has since increased to 29,000. (HP employs about 300,000 people worldwide.)

Next in the manual: lower expectations. As reported by Business Insider, HP’s CEO calls 2013 a “fix and rebuild” year, warning that the company will experience a “broad-based profit decline”. But there’s a silver lining: Whitman promises that HP will not only hit its savings targets and complete its restructuring by the end of fiscal 2014, but that the company’s revenues will be “growing in line with gross domestic product”…by 2016. (A high-tech Valley company that won’t reach GDP growth rates for three years… really?)

Further, after stating how important smartphones are to HP…

“My view is we have to ultimately offer a smartphone because in many countries of the world, that is your first computing device.”

…Whitman makes it clear that we shouldn’t expect an HP device in 2013. Does this mean that HP will introduce a smartphone in 2014 when Samsung and Apple will have taken complete control of the market? With all due respect, Whitman shouldn’t take IDC’s bizarre and fluctuating predictions seriously (11% market share for Windows Phone by 2016). Few people do outside of Redmond.

Next up: Write-offs. Here, Meg doesn’t go for small numbers, starting with a $3.3B Palm/WebOS asset zap. As the übergizmo article points out, the Palm misadventure cost shareholders close to $5B. Imagine what a startup could do with that kind of money.

And then there’s EDS, an IT services company founded by the industry legend Ross Perot and acquired by HP in 2008. Whitman decided to write off $8B of the $13.8B purchase price (58%) and, in a masterful stroke of corpospeak, managed to convince an IDC analyst that this was “Really Good News In Disguise“. Yes, that’s exactly the point of the Turnaround Artist Manual.

The grand finale is the Autonomy write-off. Acquired in August 2011 for $11.1B, HP’s official documents at the time called the acquisition “accretive“, that it would add to shareholder wealth. It sounded like a great idea: HP would have vaulted itself into the front of the pack in the exploding unstructured data applications sector.

A year later, HP’s CEO writes down Autonomy to the tune of $8.8B — 80% of the acquisition price tag. In an alternate reality, Whitman places hand on heart and takes the blame:

“I was on HP’s Board of Directors when we made the decision to acquire Autonomy. I have been part of the problem and I will now lead the solution. I’m committed to give Autonomy the place it deserves in HP’s products portfolio.”

Wall Street grumbles a bit, but the industry — and the company — applauds Whitman’s frankness, her leadership by example.

But that’s not what happened. In the aftermath of the Autonomy fiasco, Whitman blames everyone but herself and the current HP directors. First she points a finger at her predecessor, Leo Apotheker. Leo smiles and benignly lets it be known he is ready to help: “I will make myself available, however I can, to assist HP…”

(Apotheker has since assumed a more assertive stance in reminding everyone of the role that Ray Lane, HP’s chairman, played in the Autonomy transaction: “No single CEO is ever able to make a decision on a major acquisition in isolation… and certainly not without the full support of the chairman of the board.”)

Whitman then focuses on the company’s then-CTO, Shane Robison, who led the team that performed the due diligence. Blaming the well-liked Robison, who recently — and conveniently — retired, hasn’t won Whitman any friends inside the company.

Finally, she accuses Mike Lynch, Autonomy’s founder and CEO, of “accounting improprieties”. HP considers a referral to the SEC’s Enforcement Division and the UK’s Serious Fraud Office, and threatens to force Lynch to testify “under the penalty of perjury“.

The amount of the alleged fraud, around $100M, can also be explained by revenue recognition difficulties. These are not infrequent, especially when different accounting standards are involved, IFRS for most European companies (such as Autonomy), vs. GAAP in the US.

And, yes, the $100M “problem” would impact the transaction price by perhaps $1.5B, but that leaves another $5B to account for. (About $2B of the Autonomy write-off come from convolute but legit accounting mechanics tied to HP’s own stock price decline.)

Despite this discrepancy, Whitman attributes the bulk of the write-off to irregularities under Lynch’s regime. Catherine Lesjak, HP’s CFO, explains it thus [emphasis mine]:

The majority of this impairment charge [i.e. write-off] is linked to serious accounting improprieties, disclosure failures and misrepresentations that occurred prior to HP’s acquisition of Autonomy and the associated impact on the financial performance of the business over the long term.”

Vague words such as “associated impact” and “long term” purposefully confound a modest revenue recognition question with a much bigger problem. Many think the accounting snafu is a smoke screen: The Autonomy acquisition was simply a bad decision.

With Autonomy, Meg Whitman may have gone one write-off too far. Mike Lynch is a Larry Ellison-grade adversary: intelligent, articulate, aggressively entrepreneurial, with a willingness to create a reality distortion field around his company and an unwillingness to back down.

Lynch immediately writes to HP’s Board and demands proof of the allegations. Nothing so far. He then launches a website to buttress his defense and counterattack. His thesis is simple:
– First, Autonomy’s books were vetted by world-class accounting and consulting firms (Deloitte and KPMG) during the acquisition’s due diligence process.
– Second, HP’s Board of Directors, which comprises industry experts such as Ray Lane (ex-Oracle) and Marc Andreessen (ex-Netscape, Opsware, and founder of the Andreessen Horowitz venture firm) to say nothing of Meg herself, unanimously supported the acquisition proposed by Léo, himself an Enterprise Software expert (22 years at SAP).
– Third, Lynch contends that HP’s ponderous bureaucracy completely misunderstood and mismanaged the entrepreneurial culture that made Autonomy successful. As a result, key people left and the business is now in shambles.

The too-convenient Autonomy write-off and the attacks on Lynch could badly backfire. Legal action against Autonomy’s founder could open a Pandora’s box of embarrassing information.

For example, at its October 3rd analyst meeting, HP tells Wall Street that 2013 profits will fall below expectations, $3.40 to $3.60 per share vs. earlier estimates of $4.16. The stock hits a 9-year low. That same day, HP puts out a lengthy (2056 words) news release as well as a link to the presentations to be used at the meeting. I downloaded the (excellent) slides, looked for the word “Autonomy”, and found a mere footnote in Meg’s presentation and, elsewhere, an upbeat slogan: “Taking Autonomy from start-up to grown-up”…. Neither the CEO nor Cathie Lesjak, the CFO, said a word to tell shareholders trouble was brewing.

Seven weeks later, HP reveals that the investigation into Autonomy’s alleged accounting improprieties had been going on since last May when an insider blew the whistle. If Whitman and her staff are invited by Lynch’s lawyers to give depositions under the  “penalty of perjury” they earlier waved in his face, they could face some painful What Did You Know and When Did You Know It questions.

HP was once a pillar of Silicon Valley, a shining example of technical and managerial culture at their best. Today, insignificance and mediocrity loom. Does Whitman, who waves a Make It Matter slogan to rally troops, really think an ugly, mud-slinging fight will make things better?

JLG@mondaynote.com

Google’s looming hegemony

 

If we factor Google geospatial applications + its unique data processing infrastructure + Android tracking, etc., we’re seeing the potential for absolute power over the economy. 

Large utility companies worry about Google. Why? Unlike those who mock Google for being a “one-trick pony”, with 99% of its revenue coming from Adwords, they connect the dots. Right before our eyes, the search giant is weaving a web of services and applications aimed at collecting more and more data about everyone and every activity. This accumulation of exabytes (and the ability to process such almost unconceivable volumes) is bound to impact sectors ranging from power generation, transportation, and telecommunications.

Consider the following trends. At every level, Western countries are crumbling under their debt load. Nations, states, counties, municipalities become unable to support the investment necessary to modernize — sometimes even to maintain — critical infrastructures. Globally, tax-raising capabilities are diminishing.

In a report about infrastructure in 2030 (500 pages PDF here), the OECD makes the following predictions (emphasis mine):

Through to 2030, annual infrastructure investment requirements for electricity, road and rail transport, telecommunications and water are likely to average around 3.5% of world gross domestic product (GDP).

For OECD countries as a whole, investment requirements in electricity transmission and distribution are expected to more than double through to 2025/30, in road construction almost to double, and to increase by almost 50% in the water supply and treatment sector. (…)

At present, governments are not well placed to meet these growing, increasingly complex challenges. The traditional sources of finance, i.e. government budgets, will come under significant pressure over the coming decades in most OECD countries – due to aging populations, growing demands for social expenditures, security, etc. – and so too will their financing through general and local taxation, as electorates become increasingly reluctant to pay higher taxes.

What’s the solution? The private sector will play a growing role through Public-Private-Partneships (PPPs). In these arrangements, a private company (or, more likely, a consortium of such) builds a bridge, a motorway, a railroad for a city, region or state, at no expense to the taxpayer. It will then reimburse itself from the project’s cash-flow. Examples abound. In France the elegant €320m ($413m) viaduct of Millau was built — and financed — by Eiffage, a €14 billion revenue construction group. In exchange for financing the viaduct, Eiffage was granted a 78-year toll concession with an expected internal rate of return ranging from 9.2% 17.3%. Across the world, a growing number of projects are built using this type of mechanism.

How can a company commit hundreds of millions of euros, dollars, pounds with an acceptable level of risk over several decades? The answer lies in data-analysis and predictive models. Companies engineer credible cash-flow projections using reams of data on operations, usages patterns and components life cycles.

What does all this have to do with Google?

Take a transportation company building and managing networks of buses, subways or commuter trains in large metropolitan areas. Over the years, tickets or passes analysis will yield tons of data on customer flows, timings, train loads, etc. This is of the essence when assessing the market’s potential for a new project.

Now consider how Google aggregates the data it collects today — and what it will collect in the future. It’s a known fact that cellphones send back to Mountain View (or Cupertino) geolocalization data. Bouncing from one cell tower to another, catching the signal of a geolocalized wifi transmitter, even if the GPS function is turned off, Android phone users are likely to be tracked in realtime. Bring this (compounded and anonymized) dataset on information-rich maps, including indoor ones, and you will get very high definition of profiles for who goes or stays where, anytime.

Let’s push it a bit further. Imagine a big city such as London, operating 500,000 security cameras, which represent the bulk of the 1.85 million CCTVs deployed in the UK — one for every 32 citizens. 20,000 of them are in the subway system. The London Tube is the perfect candidate for partial or total privatization as it bleeds money and screams for renovations. In fact, as several people working at the intersection of geo applications and big data project told me, Google would be well placed to provide the most helpful datasets. In addition to the circulation data coming from cellphones, Google would use facial recognition technology. As these algorithms are already able to differentiate a woman from a man, they will soon be able to identify (anonymously) ethnicities, ages, etc. Am I exaggerating ? Probably not. Mercedes-Benz already has a database of 1.5 million visual representations of pedestrians to be fed into the software of its future self-driving cars. This is a type of applications in which, by the way, Google possesses a strong lead with its fleets of driverless Prius crisscrossing Northern California and Nevada.

Coming back to the London Tube and its unhappy travelers, we have traffic data, to some degree broken down into demographics clusters; why not then add shopping data (also geo-tagged) derived from search and ads patterns, Street View-related informations… Why not also supplement all of the above with smart electrical grid analysis that could refine predictive models even further (every fraction of percentage points counts…)

The value of such models is much greater than the sum of their parts. While public transportation operators or utility companies are already good at collecting and analyzing their own data, Google will soon be in the best position to provide powerful predictive models that aggregate and connect many layers of information. In addition, its unparalleled infrastructure and proprietary algorithms provide a unique ability to process these ever-growing datasets. That’s why many large companies over the world are concerned about Google’s ability to soon insert itself into their business.

frederic.filloux@mondaynote.com